Is peat swamp worth more than palm oil plantations?

/ Rhett A. Butler

Could peat swamp be worth more intact for their carbon value than palm oil plantations for their oil? Quick analysis suggests yes, though binding limits on emissions will be needed to trigger the largest ever flow of money from the industrialized world to developing countries. At stake: the bulk of the world's biodiversity.

Is peat swamp worth more than palm oil plantations?

Is peat swamp worth more than palm oil plantations?

Rhett A. Butler, mongabay.com

July 16, 2007 [Jakarta Post version published Aug 22]


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Could peat swamp be worth more intact for their carbon value than palm oil plantations for their oil? Quick analysis suggests yes, though binding limits on emissions will be needed to trigger the largest ever flow of money from the industrialized world to developing countries. At stake: the bulk of the world’s biodiversity.


In recent months there has been a lot of talk about the use of carbon credits to help offset greenhouse gas emissions. There has also been discussion about the ecological damage being wrought by biofuels, which has encouraged-oil palm plantations in the biodiverse rainforests of Indonesia. It turns out the two are closely linked. When forest is cleared and peat swamps are drained for the establishment of oil-palm plantations, large amounts of carbon dioxide are released into the atmosphere. In Indonesia so much CO2 is released from these processes that Wetlands International, a Dutch NGO, estimates that in some years Indonesia may produce 8 percent of global emissions. The U.N. agrees.

So why aren’t palm-oil plantations simply banned in Indonesia? Well, beyond the fact that it would be unethical and illegal, palm-oil plantations are immensely profitable in areas where there is little other meaningful economic activity. At the current price of $750 per metric ton of palm oil, a mature oil-palm plantation can generate more than $3,000 per hectare for a large landholder. Internal rates of return can top 25 percent a year over 25 years, a remarkable rate for a simple agricultural commodity, even one that is the world’s most productive oilseed.



Chart showing annual palm oil production by Malaysia and Indonesia from 1964-2006. Click to enlarge.

Given this profitability, oil-palm plantations in Indonesia have expanded from 600,000 hectares in 1985 to more than 6 million hectares by early 2007, and are expected to reach 10 million hectares by 2010. In those 22 years Indonesian palm-oil production has increased from 157,000 metric tons to 16.4 million metric tons, while exports have jumped from 126,000 metric tons to 12 million metric tons.

So what’s the alternative? Is there anything that could make Indonesian business abandon this steady source of income by offering an even more attractive stream of income? The answer may be surprising. Preserving forest and peat swamp that would otherwise be converted and collecting the resulting recurrent revenue provided by the carbon offset market may be more lucrative for landowners in some areas.

Peat swamps

While most people think of peat swamps as little more than a breeding ground for disease-carrying insects and threatening wildlife, leaving it as is could be quite profitable for landowners under carbon finance initiatives for the simple reason that peat swamps store massive amounts of carbon.

Peatlands, formed by organic deposits comprised of partially decayed plant matter that accumulates over hundreds of years, cover more than 400 million hectares of land worldwide. Most of these exist in permafrost in the far north, though some are found in the lowlands of tropical Asia, especially in the swampy forests of Indonesia and Malaysia. Peatlands are giant reservoirs of carbon, storing around 2,000,000 million tons of carbon dioxide globally. Southeast Asian peatlands alone lock up 42,000 million tons of carbon, according to Wetlands International. However, when peatlands are drained, cut, or burned this stored carbon is released into the atmosphere, contributing to climate warming.



Chart showing annual palm oil production and exports for Indonesia from 1964-2006. Click to enlarge.

Each year hundreds of thousands of hectares of peatlands are drained and cleared for oil-palm and timber plantations. Generally, developers dig a canal to drain the land, extract valuable timber, then clear the vegetation using fire. In dry years these fires can burn for months, contributing to the “haze” that regularly plagues Southeast Asia. Fires in peatlands are especially persistent, since they can smolder underground for years even after surface fires are extinguished by monsoon rains.

While burning releases enormous amounts of carbon dioxide, merely draining peatlands also contributes to global warming—upon exposure to air, peat rapidly oxidizes, decomposes, and releases carbon dioxide. Further carbon—about 70 percent of emissions—is released when peatlands are burned. Wetlands International estimates that production of one metric ton of palm oil will result in an average emission of 20 tons of carbon dioxide from peat decomposition alone, not including emissions resulting from production or combustion.

Beyond contributing to climate change, destruction of peatlands in Indonesia puts local populations at greater risk of flooding. Peatlands are a natural means of flood control, acting like a sponge to absorb large amounts of rainfall and runoff, while reducing the threat of erosion.

The opportunity

When peatlands are degraded and trees are cut, greenhouse gases are released into the atmosphere. “Avoided deforestation” is the concept in which countries are paid to prevent deforestation that would otherwise occur. Funds come from industrialized countries seeking to meet emissions commitments under international agreements like the Kyoto Protocol. Policymakers and environmentalists alike find the idea attractive because it could help fight climate change at a low cost while improving living standards for some of the world’s poorest people, safeguarding biodiversity, and preserving other ecosystem services. A number of prominent conservation biologists and development agencies, including the World Bank and the U.N., have already endorsed the idea, which may be one of the most cost-effective ways to slow climate change.

In Indonesia the concept offers an alternative to the current single-minded pursuit of oil-palm plantation expansion, a trend that increasingly ties Indonesia’s economy to the price of a single commodity. By shifting toward “avoided deforestation” carbon credits, Indonesia can diversify its economy, improve returns, and reduce risk without depleting its resource base.

An illustration

To illustrate the potential, compare the net present value (NPV) of a standard 1,000-hectare oil-palm plantation to a 1,000-hectare peat swamp preserved for its carbon value. Bear in mind that small-holder plantations are considerably less profitable than large ones, with higher transactions costs, and therefore would present an even more compelling case for leaving ecosystems intact for carbon credits.

Palm oil plantation

Start-up costs. Oil-palm plantations have considerable up-front costs for land-clearing, preparing irrigation systems, and planting. Start-up costs for a plantation may range from $500 to more than $3,000 per hectare. According to information provided by the Oil Palm Research Institute (IOPRI) via the World Agroforestry Centre (ICRAF), the cost of replanting of 1 hectare of oil palm is $2222. The cost for new plantation development is $2555 per hectare. Note that this estimate excludes the value of timber. In natural forest, the establish of oil palm plantations is sometimes a cover for logging. In fact, according to a paper by Lesley Potter of Australian National University, only 303,000 hectares of the 2 million hectares of land in East Kalimantan reserved for oil-palm development had been planted by 2004, while an estimated 3.1 million hectares of forest was cleared under the guise of plantation development. Nevertheless, for the purpose of this example, a start-up cost of $2555 per hectare, or $2.55 million for 1000 hectares, was used.

Yield. While oil palm is the most productive oilseed in the world, trees do not start producing oil-rich fruit until after at least 30 months [A new variety may shorten this to 24 months). Fruit grows in clusters that may weigh 40-50 kilograms, enough to produce 10 kilograms of oil once mature. During the first years of fruit production, yield is only a fraction of that of a mature plant. According to the Oil Palm Research Institute (IOPRI), after four years, each hectare yields 12-15 metric tons (Mt) of oilseed, or 2.6-3.3 Mt of crude palm oil worth roughly $1950-2475 at current market prices (though the landowner would recieve a lower price for his oil) but before expenses which generally run 20-30 of revenue. At peak production, after eight or nine years years, each hectare may yield from 26-31 Mt of oilseed (depending on land suitability), or 5.7-7 Mt of palm oil in efficient plantions. Under less suitable conditions yields ay be up to a third lower. While oil palms can live longer than 150 years and exceed 80 feet in the wild, cultivated palms are generally clear cut or poisoned once they are about 25 years old when they stand around 30 feet tall. Beyond 30 feet, harvesting fruit clusters is a challenge. Therefore oil-palm plantations have a useful life of around 25 years, after which they are cleared. In Malaysia, where operations are generally efficient, oil palm plantations can be reestablished after clearing. On government-run estates and community plantations in some parts of Indonesia, land is often abandoned following clearing due to poor agricultural practices.


Yield over the 25-year lifetime of an oil palm plantation in Indonesia. Figures courtesy of Oil Palm Research Institute (IOPRI) via the World Agroforestry Centre (ICRAF).



Chart by Rhett A. Butler.

Production costs and net income. Fruit clusters are harvested by hand, usually by hired laborers. In Malaysia, much of palm-oil harvesting is done by foreign workers, often Indonesians. In Indonesia, poor farmers, often waiting for their own meager (2-3 hectare) plantations to mature, provide the labor. They may earn $2.50 per day for their efforts.

It is generally accepted that large oil palm plantations break even from a net present value standpoint in year 7 or 8. Small plantations take longer. For the purpose of this example, all costs other than plantation start-up costs were excluded.

Discount and interest rates. For the purpose of these examples, 16 percent was used as the discount/cost of capital rate and interest rate. While discount rates generally fall between 10 and 20 percent, interest rates can be higher in rural Indonesia, especially for small landholders who are known to become trapped in debt-bondage schemes by financiers and large-landowners. Under the first scenarios, the $2.55 million loan is accompanied by a line-of-credit to finance interest on interest for the first four years, until there is net income.

Peat swamp preserved for carbon value




Rainforest clearing for an oil palm plantation in Borneo. Seen from above and at ground level. Photos by Rhett A. Butler.

The peat swamp preserved for its carbon value does not have appreciable start-up costs relative to the oil-palm plantation. While there may be costs associated with surveying and demarcating the land, they are quite small in comparison. For the purpose of this example, it is assumed that the peat swamp stores 250 Mt more carbon than would otherwise be stored it if were drained and converted for oil palm. Some peat forest—forest that grows on peatlands—can store more than 500 Mt of carbon per hectare. Even non-peat forest can store upwards of 400 Mt of carbon per hectare (i.e., in northern parts of the Amazon basin). For the scenarios it was assumed that the development of the plantation would result in a peat swamp drainage that would result in CO2 emissions of 86 Mte per hectare or carbon emissions of 27 Mt/ha/yr per year. Initial forest clearing was assumed to release 100 Mt of carbon.

In the scenarios, carbon credits are assigned various values, based on real-world market values for 2006. At the low end ($3.50) is the average price of “voluntary emissions reductions” (VER) credits on the Chicago Climate Exchange (CCX) in 20006. Note that though credits are voluntary in the United States, they have value. At the high end ($22.12) is the average 2006 price for the EU ETS Trading Scheme. Also included is the average 2006 price ($18.60) across all 5 established offset mechanisms (EU ETS Trading Scheme, Primary Clean Development Mechanism, Secondary Clean Development Mechanism, Joint Implementation, New South Wales). The World Bank and Stern Report put values of carbon damage even higher. Phase II of the Emissions Trading System (ETS), Europe’s system for trading carbon credits, will impose a $130 penalty (€100) per ton for non-compliance among firms.


Results


Net present value (NPV) of 1000-ha (2500-acre) peat swamp vs oil palm plantation. Chart shows the effect of palm oil at various prices and various carbon trading schemes. Assumptions: 15% discount/10% interest rate; Year 1: 100 tons of C/ha, 27 tons of C/ha (=100 tCO2e/ha) in years thereafter; medium average palm oil yield of 5.3 tons per hectare per year over the 25 year period.



Calculations and charts by Rhett A. Butler.


The graphs show that under some conditions, preserving peat swamps for carbon offsets is an attractive proposition relative to converting land for oil-palm plantations. Maintaining peat swamp as a productive ecosystem also has the potential to offer other financial benefits to land-holders, especially if compensation programs for ecosystem services, including watershed protection and biodiversity preservation, come to fruition. Further, intact peatland can offer opportunities for low-impact ecotourism activities, like bird-watching and wildlife spotting, and provide option value—that is, having these ecosystems intact leaves landowners with more options on how to make best use of the land than they would have had if they had already had cleared it.


Tropical deforestation rates from 2000-2005, ranked in decending order by the highest amount of average annual forest loss for 25 countries based on data from the U.N. Food and Agriculture Organization (FAO). Image by Rhett A. Butler, click to enlarge

Carbon finance is not limited to peatlands or Indonesia. Compensation for forest preservation is at least applicable to any tropical country where forest is being cleared, resulting in greenhouse gas emissions. With more than 13 million hectares of forest per year being cleared, releasing around 20 percent of global greenhouse gas emissions, the opportunity is tremendous. Indonesia alone lost 1.9 million hectares of forest per year between 2000 and 2005, but even a small country like the Solomon Islands could see immediate benefits under the establishment of a global framework on “avoided deforestation.”

Conclusion

Climate change presents serious risks to Indonesia, including drought, flood, and sea-level rise. However proposed mechanisms for addressing climate change, notably carbon credits, offer an unparalleled economic opportunity for the country. It’s time for Indonesia and other countries that will bear the brunt of climate change to reap some of the rewards of their valuable ecosystems.



Note:

  • This model is simplistic and does not factor in opportunity costs, options values, price volatility risk, taxes on CO2 emissions, or ecosystem services values.

  • Logging income is excluded from this model. In many forest areas, logging income from initial clearing is used to fund oil palm plantation establishment. Please see the model below for a comparison of the cost replanting an oil palm plantation.
  • More carbon finance news articles



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    Please note. These calcuations are still in flux as new data is processed.




    Comparison of the net present value (NPV) of 1000-ha (2500-acre) peat swamp vs oil palm plantation. Chart shows the net present value of palm oil at $750 per metric ton for various plantation establishment costs and carbon for various offset schemes. Assumptions: 15% discount/10% interest rate; Year 1: 100 tons of C/ha, 27 tons of C/ha (=100 tCO2e/ha) in years thereafter; medium average palm oil yield of 5.3 tons per hectare per year over the 25 year period.



    Calculations and charts by Rhett A. Butler.



    A note about the intended audience for this editorial

    This editorial was targeted for the business community in Indonesia; specifically companies that already own forest land and are considering clearing it for oil palm. As such, the focus was on profitability.

    To look at the broader benefits of carbon finance, it would be better to use total revenue rather than net income as well as incorporate some of the other ecosystem services afforded by intact forest.

    An important component in carbon finance is ensuring that it is structured so that local communities benefit financially, especially through employment. On state- and community-owned lands, carbon finance would be used to fund sustainable development initiatives, like planting crops on degraded lands and reforestation. Local people could continue to subsist from forest areas (possibly non-market timber harvesting, hunting, and collection of forest products like rattan, fruit, and nuts) without degrading the carbon value of the land. Further, in some areas eco-tourism would be a possibility. All the initiatives would be financed using the income from offsets.



    Carbon offsets may someday offer the possibility that protected areas could seek compensation for their carbon value. While compensation would come at a fraction of “avoided deforestation” rates, it still raises the prospect that parks could become self-sustaining from a economic standpoint.



    – Rhett

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